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Employment effects of minimum wages Updated

When minimum wages are introduced or raised, are
there fewer jobs?

Elevator pitch

The potential benefits of higher minimum wages
come from the higher wages for affected workers, some of whom are in poor or
low-income families. The potential downside is that a higher minimum wage
may discourage firms from employing the low-wage, low-skill workers that
minimum wages are intended to help. If minimum wages reduce employment of
low-skill workers, then minimum wages are not a “free lunch” with which to
help poor and low-income families, but instead pose a trade-off of benefits
for some versus costs for others. Research findings are not unanimous, but
especially for the US, evidence suggests that minimum wages reduce the jobs
available to low-skill workers.

Key findings

Pros

Minimum wages may help policymakers address public demands to
combat rising inequality.

Minimum wages deliver earnings gains for some
workers.

Some
of the workers who gain from minimum wages are in poor or
low-income families.

Some
studies do not find that minimum wages lead to fewer
jobs.

Cons

Increasing amounts of evidence from the US indicate that higher
minimum wage levels lead to fewer jobs.

Studies that focus on the least-skilled workers find the
strongest evidence that minimum wages reduce jobs.

Targeted tax credits do a better job of reaching the poor than
minimum wages do.

Low-paying jobs requiring low skills are the jobs most likely
to decline with increased minimum wages.

In the
US, most evidence does not indicate that minimum wages help poor
or low-income families, or reduce most forms of public
assistance.

Author's main message

Higher minimum wages are becoming the norm in many
countries. Although a minimum wage policy is intended to ensure a minimal
standard of living, unintended consequences undermine its effectiveness. A
good deal of evidence indicates that the wage gains from minimum wage
increases are offset, for some workers, by fewer jobs. Furthermore, the
evidence on distributional effects, though limited, does not point to
favorable outcomes from minimum wage hikes, although some groups may
benefit. Other mechanisms, such as earned income tax credits, appear more
effective at helping low-income families.

Motivation

The main case for a minimum wage is that it helps
poor and low-income families earn enough income. However, the potential
downside is that it may discourage employers from using low-wage, low-skill
workers. If minimum wages reduce employment for low-skill workers, winners and
losers will emerge. Whether a minimum wage reduces poverty or helps
low-income families then depends on where along the distribution of family
incomes these winners and losers are located. Clearly, the effect on jobs is
critical: if a higher minimum wage does not destroy jobs, then from the
government’s perspective it is a “free lunch” that helps reduce poverty,
even if higher-income families also benefit. Labor economists have long
studied whether minimum wages reduce employment. This article looks at the
accumulated US evidence, and also at the reliability of the underlying
research methods for estimating the effects of the minimum wage on jobs.

Discussion of pros and cons

Theory

Textbook analyses of minimum wages portray a
competitive labor market for a single type of labor, with an
upward-sloping labor supply curve and a downward-sloping labor demand
curve. With no minimum wage, there is an equilibrium wage, w, and an equilibrium quantity of labor
employed, L (Figure 1).

With a “binding” minimum wage mw that is higher than w, fewer workers are employed, for two reasons. First,
employers substitute away from the now more expensive labor and toward
other inputs (such as capital). Second, because costs are higher with
this new input mix, product prices rise, which further reduces labor
demand. These two effects lead to lower employment—Lmw in Figure 1.

Of course, this model oversimplifies. One
issue is that workers have varying skill levels, and minimum wages are
unlikely to matter for higher-skill workers. Employers will substitute
away from less-skilled workers toward more-skilled workers after a
minimum wage increase. This “labor−labor” substitution has implications
for empirical evidence on the employment effects of minimum wages. The
employment declines might not appear to be large, even if the
disemployment effect
among the least-skilled workers is strong. This is relevant from a
policy perspective. The minimum wage is intended to help the
least-skilled workers. If their employment declines substantially (i.e. being put out of work; this can arise due to
displacement from a current job or difficulty finding a new job), the
policy is less likely to achieve its goal.

A more fundamental challenge to the
competitive model is that it is simply the wrong model. Some argue that
there can be “monopsony” in labor markets, i.e. where employers have
some power over setting wages, in contrast to the competitive model,
because of frictions that tie workers to specific firms. These frictions
imply that when an employer hires another worker, the cost of existing
workers also increases. As a consequence, market-determined employment
can fall below the economically efficient competitive level. Moreover,
in the monopsony model, a minimum wage can sometimes lead to higher
employment.

Evidence

Economists describe the effect of minimum
wages using the employment elasticity, which is the ratio of the
percentage change in employment to the percentage change in the
legislated minimum wage. For example, a 10% increase in the minimum wage
reduces employment of the affected group by 1% when the elasticity is
−0.1 and by 3% when it is −0.3.

Earlier studies finding
disemployment effects

Through the 1970s, many early studies of
the employment effects of minimum wages focused on the US. These
studies estimated the effects of changes in the national minimum
wage on the aggregate employment of young people, typically 16−19
year-olds or 16−24 year-olds, many of whom have low skills. The
consensus of these first-generation studies was that the
elasticities for teen employment clustered between −0.1 and
−0.3.

Limited evidence from the 1990s challenged
this early consensus, suggesting that employment elasticities for
teenagers and young adults were closer to zero. But subsequent
research, using more up-to-date methods for analyzing aggregate
data, found stronger evidence of disemployment effects, in line with
the earlier consensus. Using data through 1999, the best of these
studies found teen employment elasticities of −0.12 in the short
term(i.e. less than one year) and −0.27 in the longer term, thus
apparently confirming the earlier consensus: minimum wages reduce employment of young (and hence unskilled) people, and the elasticity
ranges between −0.1 and −0.3.

In the early 1990s, a second, more
convincing wave of research began to exploit emerging variation in
minimum wages across states within the US. Such variation provides
more reliable evidence because states that increased their minimum
wages can be compared with states that did not, which can help
account for changes in youth employment occurring for reasons other
than an increase in the minimum wage. A related literature focuses
on specific cases of state minimum wage increases. This case study
approach offers the advantage of limiting the analysis to include
one state where the minimum wage increases and another very similar
state that is a reasonable comparator. Unfortunately, these results
do not necessarily apply in other states and at other times.

An extensive review of this newer wave of
evidence looked at more than 100 studies of the employment effects
of minimum wages, assessing the quality of each study and focusing
on those that are most reliable [1]. Studies focusing on the
least skilled were highlighted, as the predicted job reduction
effects of minimum wages were expected to be more evident in those
studies. Reflecting the greater variety of methods and sources of
variation in minimum wage effects used since 1982, this review
documents a wider range of estimates of the employment effects of
the minimum wage than was found in earlier—predominantly
time-series—studies.

Nearly two-thirds of the studies reviewed
estimated that the minimum wage had negative (although not always
statistically significant) effects on employment. Only eight found
positive employment effects. Of the 33 studies judged the most
credible, 28, or 85%, pointed to negative employment effects. These
included research on Canada, Colombia, Costa Rica, Mexico, Portugal,
the UK, and the US. In particular, the studies focusing on the
least-skilled workers find stronger evidence of disemployment
effects, with effects near or larger than the consensus range in the
US data. In contrast, few—if any—studies provide convincing evidence
of positive employment effects of minimum wages.

Challenges to the
consensus

Two recent meta-analyses challenge this
conclusion [2], [3]. These analyses suggest
that averaging across studies points to an estimate near zero.
However, averaging across estimates from studies of minimum wage
effects, as meta-analyses do, is problematic. First, the population
studied varies; this and other factors can influence how binding the
minimum wage is. This leads to variation in estimated effects, for
which there is no reason to simply average. Second, meta-analyses
often assign more weight to estimates that are more statistically
precise [3], even though the most
rigorous empirical methods are likely to be less precise because of
more rigorous research designs. And yet, it is the studies that use
the most rigorous methods—if valid—that should receive the most (if
not all the) weight. Thus, attention should be paid to the best
studies; even if researchers do not yet agree on which studies are
best, it is more meaningful to try to resolve this question than to
mechanically average across existing estimates in the literature.

The conclusions of the survey of studies
above have been sharply contested in two more-recent studies [4], [5]. The authors of these
studies assume that state minimum wages tend to increase in states
and years when labor market conditions for less-skilled workers are
in decline relative to other states, generating a spurious negative
relationship between minimum wages and low-skilled employment. They
also assert that restricting comparisons to nearby states, when
minimum wages increase in one state but not its neighbors, solves
this problem, because nearby states are subject to the same shocks
that may be spuriously correlated with minimum wage increases. Using
these “close comparisons,” both studies find disemployment effects
that are near zero. The first focuses on restaurant workers [4] and the second on teenagers
[5].

Two recent re-analyses of these studies
dispute many of the conclusions [6], [7]. Moreover, three studies
using three different approaches to the problem of labor market
shocks correlated with minimum wage increases [8], [9], [10] find strong disemployment
effects of minimum wages, with elasticities ranging from about −0.3
to −0.5 for teenagers, and near –1 for the very lowest-wage workers
[9]. There are several reasons
to find these other studies more convincing [11], not least of which is
because the close-controls method used in the earlier studies may
obscure the disemployment effects of minimum wages.

The key empirical takeaway is that the
exceptions in recent work that find no evidence of employment
effects [4], [5] generally come from one
specific way of estimating the employment effects of minimum
wages—focusing on geographically-proximate controls.Meanwhile,
several other methods in the most recent research, which also
confront the same potential limitation of prior research, find
disemployment effects [8], [9], [10]. At a minimum, even if one
has somewhat different views about these alternative studies,
blanket statements claiming that there is no evidence that raising
the minimum wage costs jobs are simply untrue.

Minimum wages in other
countries

By far the largest number of studies use
US data because state-level variation provides the best “laboratory”
for estimating minimum wage effects. Many other countries, including
Germany, have a national minimum wage. A national minimum wage poses
greater challenges to social scientists, because it is difficult to
estimate what would have happened in the absence of a minimum wage
increase. This challenge is also reflected in the UK studies. Absent
variation in minimum wages across regions in the UK, one recent
study examines groups differentially affected by the national
minimum wage, finding employment declines for part-time female
workers, the most strongly affected group. A second study looks at
changes in labor market outcomes at ages when the UK minimum wage
changes—at 18 and 22—and finds a negative effect at age 18 and at
age 21 (a year before the minimum wage increases, which the authors
suggest could reflect employers anticipating the higher minimum wage
at age 22). However, there are numerous UK studies that do not find
disemployment effects (see Additional references).

Interpreting the magnitude
of estimated disemployment effects

Many concede that the evidence is more
consistent with disemployment effects of minimum wages, but suggest
that these effects are small or modest. One way to gauge what
“small” or “modest” means is to compare the employment elasticities
to the value −1; even if negative, an elasticity smaller than −1 in
absolute value has been interpreted as meaning that earnings gains
from higher wages will far offset the earnings declines from job
losses [12].

However, this is not the correct way to
translate the employment elasticity from minimum wage studies. Most
studies do not focus solely on affected workers, which means the job
loss they estimate could be much higher as a percentage of workers
who could potentially benefit from the higher minimum wage. In
addition, elasticities estimated from most existing minimum wage
studies overstate the wage gain, because they are computed in terms
of the legislated increase in the minimum wage;however, typically,
some affected workers are already earning more than the old minimum
wage (but less than the new minimum wage), so the size of the
average wage increase for them will be smaller than the minimum wage
increase itself. It might be quite reasonable to think thatadjusting
for these factors could bring the elasticity close to −1, or even
larger (in absolute value). Indeed, this is consistent with the
estimated elasticity near −1 found for directly affected workers
[9], and with recent evidence
on the effects of the Seattle minimum wage. The implication is that
minimum wages may have little impact on earnings of affected
workers, on average.

Distributional effects and impact on
poverty—In brief

The main argument proffered in favor of a
minimum wage is that it helps poor and low-income families. But because
there are some disemployment effects, minimum wages create winners and
losers. The winners get a higher wage with no reduction in employment
(or hours), while the losers bear the burden of the disemployment
effects—losing their job, having their hours reduced, or finding it more
difficult to get a job. If the gains to the winners are large, if these
winners are disproportionately from the low-income families that
policymakers would like to help, and if the losses are concentrated
among higher-income workers or other groups from whom policymakers are
willing to redistribute income, then the losses experienced by the
losers from a minimum wage increase may be deemed acceptable. However,
research on the US fails to find evidence that minimum wages help the
poor; they may actually increase the number of poor and low-income
families.

The fundamental problem with using minimum
wages to increase the incomes of poor and low-income families is that
the policy targets low-wage workers, not low-income families, which are
not necessarily the same. In the US, the link between low wages and low
family income is quite weak, for three reasons. First, over half (57%)
of poor families with heads of household aged 18–64 have no workers
(calculations based on 2014 Current Population Survey data). Second,
some workers are poor because of low hours rather than low wages; in the
same data, 46% of poor workers have hourly wages above $10.10, and 36%
have hourly wages above $12. And third, because teenagers are highly
overrepresented in the minimum wage workforce, many low-wage workers are
not in poor families. As a result, back-of-the-envelope calculations
suggest that when the minimum wage is increased, assuming no job loss,
far more of the increase in income goes to families in the top half of
the income distribution than to families below the poverty line (Figure 2) [13].

Before-and-after studies that directly
estimate the distributional effects of minimum wages are more decisive.
There are far fewer such studies than there are studies of employment
effects. However, most of the existing research finds no statistical
evidence of reductions in poverty from a higher minimum wage.

In short, there is little compelling evidence
of beneficial distributional effects of minimum wages in the US.
Nonetheless, there are some open questions about the effects of minimum
wages on poverty. Most of the point estimates of the effects of minimum
wages on poverty are in fact negative, suggesting that it may be more
likely than not that the distributional effects are in the direction of
reducing poverty; a lack of statistically significant evidence does not
imply that there is no effect. At the same time, looking across the
employment and poverty results, one cannot appeal to a set of studies
that fail to find a statistically significant negative effect of minimum
wages on poverty to bolster the claim that minimum wages reduce poverty,
while also appealing (more selectively) to a set of estimates of the
effect of minimum wages on employment that are generally negative but
statistically insignificant to argue that the minimum wage does not
reduce employment.

Despite the absence of clear evidence that
minimum wages reduce poverty, does a higher minimum wage reduce the
dependence of poor and low-income families on government assistance? A
recent comprehensive US study of spending on Medicaid, welfare, and many
other programs did not find that higher minimum wages lower
participation in public assistance programs, with the exception of the
Supplemental Nutrition Assistance Program (SNAP), which has work
requirements that could have been harder to fulfill owing to a higher
minimum wage [14].

The inability to help poor and low-income
families through a higher minimum wage is understandably frustrating for
policymakers. In the US, however, a far more effective policy tool is
the Earned Income Tax Credit (EITC) enacted in the 1970s. Some European
countries (e.g. the UK, Belgium, France, and the Netherlands) have
implemented similar policies. These programs pay subsidies to low-income
workers, based on family income; the subsidies are phased out as income
rises.

While the incentive effects of these subsidies
are often complicated, the subsidies, handled correctly, unambiguously
create an incentive to enter the labor market for many eligible individuals
who were not working. Moreover, the subsidies depend on family income,
thus creating incentives precisely for the families most in need of
help. Poverty rates are very high for female-headed families with
children, for example, and there is overwhelming evidence of the EITC’s
positive employment effects for single mothers. Moreover, the EITC helps
families escape poverty not simply through the EITC subsidy, but also
through the added labor market earnings generated because of the labor
supply incentive effects of the EITC [15].

Combining the EITC with a higher minimum wage
can lead to better distributional effects than the minimum wage alone,
although it increases the adverse effects of the minimum wage on other
groups [15]. That is because a higher
minimum wage coupled with an EITC can induce more people who are
eligible for the EITC to enter the labor market, while exposing people
who are not eligible for the EITC to greater competition in the labor
market, which can amplify the disemployment effects for them. An
exploration of the interactions between higher state minimum wages in
the US and the more generous state EITC programs finds that a
combination of the two policies leads to more adverse employment effects
on specific groups—like teenagers and less-skilled minority men—that are
not eligible for the EITC (or are eligible for a trivial credit), while
finding positive employment and distributional effects for single women
with children who are eligible. This research does not change the
conclusion that minimum wages reduce employment; rather, it shows that the
effects can vary across subpopulations—in this case because of
interactions with another policy.

Limitations and gaps

There are three key gaps when it comes to
understanding the effects of a minimum wage. The firstis related to the
interactions between minimum wages and other labor market institutions and
policies, the structure of the minimum wage (such as whether there is a
youth subminimum), and the ultimate disemployment effects. This question has
been explored for countries within the OECD, but the analysis needs to be
extended to developing countries as well, where the policy variation is
greater.

The second concerns how minimum wages affect
different groups and regions. For example, it would be helpful to be able to
isolate the employment effects of minimum wages on poor, low-income, and
other families to find out whether the negative effects are concentrated on
low-wage workers in low-income families. If so, this would add to the weight
of the evidence against higher minimum wages. If not, the fairly modest
disemployment effects would need to be reconciled with no apparent
beneficial distributional effects.

The third gap has appeared recently, with the
emergence of very high minimum wages. The US is embarking on an experiment
of using high minimum wages to try to increase incomes of workers and to
reduce poverty. There are now 29 states (plus the District of Columbia) with
minimum wages above the federal minimum wage, with an average difference
across states of 30.2% (see the Illustration). As a result, the federal minimum wage now provides a
floor for an increasingly narrow set of states, concentrated in the south.
Moreover, California, Massachusetts, New York, Seattle, and Washington, DC
have legislated either current or future minimum wages of $15. Other
localities may follow suit, and a change in the national political alignment
could result in a $15 national minimum. The same issues carry over to large
minimum wage increases elsewhere, such as the recent introduction of a
minimum wage in Germany in 2015, starting at a relatively high €8.50.

It is very hard to predict the effects of such
high minimum wages. First, as discussed above, the question of the
employment effects of past, smaller minimum wage increases is still
contested. More important, even if one has a strong view of what the US
literature says about the employment effects of past minimum wage increases,
the literature on past increases may provide much less guidance in
projecting the consequences of the high minimum wages that are now emerging,
which will entail much larger increases than those studied in the prior
literature. Predicting the effects of much larger minimum wage increases,
based on research studying much smaller increases, is inherently risky. For
example, the far greater share of workers affected could substantially
constrain the ability of employers to adjust along other margins and hence
mitigate potential job losses.

Summary and policy advice

While low wages contribute to the dire economic
straits of many poor and low-income families, the argument that a higher
minimum wage is an effective way to improve their economic circumstances is
not supported by the evidence.

First, a higher minimum wage discourages employers
from using the very low-wage, low-skill workers that minimum wages are
intended to help. A large body of evidence—although not all of it—confirms that minimum wages
reduce employment among low-wage, low-skill workers.

Second, minimum wages do a bad job of targeting
poor and low-income families. Minimum wage laws mandate high wages for
low-wage workers rather than higher earnings for low-income families.
Low-income families need help to overcome poverty. Research for the US
generally fails to find evidence that minimum wages help the poor, although
some subgroups may be helped when minimum wages are combined with a subsidy
program, like a targeted tax credit.

The minimum wage is a relatively ineffective
policy for achieving the goal of helping poor and low-income families. More
effective policies are those that increase the incentives for members of
poor and low-income families to work.

Acknowledgments

The author thanks two anonymous referees and the
IZA World of Labor editors for many helpful suggestions on earlier drafts.
Version 2 of the article fully revises the the text (also adding a new "Con"), figures, and reference lists as new evidence has emerged on minimum wages in the US. The additional references have been extended and include those references previously listed as further reading and key references.

Competing interests

The IZA World of Labor project is committed to the IZA Code of Conduct.
The author declares to have observed the principles outlined in the code.

Version 2 fully revises the text, figures, and reference lists as new evidence has emerged on minimum wages in the US. The additional references have been extended and include those references previously listed as further reading and key references.